Progress in the UK's nuclear energy industry has somewhat stalled in recent years.
Once favoured by policy makers as an option for delivering a low-carbon energy generation future, nuclear's slowdown began with the Fukushima disaster in Japan in 2011, which led to Germany pulling out of the nuclear industry altogether and to the subsequent withdrawal of German utility companies RWE and Eon from the UK's £20 billion Horizon nuclear project.
Then, there was the inability to find a finance model that worked for new-build nuclear plants.
This resulted in Japanese industrial group Toshiba's failure to sell its £15 billion NuGen project in late 2018 and in fellow Japanese multinational Hitachi deciding to disband the Horizon project in January this year.
Hitachi's decision came despite the UK government offering to take a one third equity stake, provide debt financing and offer a 35-year contract for difference (CfD) with a £74/MWh strike price if it continued to develop the project.
A further blow came after the June 2016 Brexit referendum, when the British nuclear industry failed to convince the Department for Business, Energy and Industrial Strategy (BEIS) to carve out the Euratom Treaty from the EU withdrawal process.
The UK has therefore had to replicate, almost entirely, a parallel domestic regulatory and trade infrastructure to that provided by Euratom.
On top of that, extended outages from advanced gas-cooled reactor (AGR) stations (which make up seven of the UK's eight nuclear power stations, the oldest of which is 43 years old and the youngest 30 years) have served as a reminder that most of those stations are now in their last few years of useful life.
The Committee on Climate Change's (CCC) Net Zero report published in May this year, endorsed the role of nuclear in its vision for achieving net zero carbon emissions from the UK by 2020, noting:
"Renewable generation could be four times today’s levels, requiring a sustained and increased build out between now and 2050, complemented by firm low-carbon power options such as nuclear power and CCS (applied to biomass or gas-fired plant)".
The CCC recognises the role low-carbon power (particularly nuclear) can and probably needs to play in complementing renewable generation, rather than assuming that renewables can rapidly and totally replace all carbon-emitting energy technologies.
Similarly, deep in its 2019 Progress Report published in July, the CCC reiterated that:
"Alongside new renewables, technologies which can offer firm and flexible power, such as nuclear and [carbon capture and storage (CCS)], will be required for a power system in 2050 contributing fully to achieving overall net zero emissions.
"The scale of deployment required by 2050 will necessitate continued investment in these options between now and 2050".
Picking up the thread, National Grid in its 2019 Future Energy Scenarios (FES 2019) introduced small modular reactors (SMRs) into its "Two Degrees" scenario, which many in the industry take as the most useful benchmark of future energy requirements.
Under that scenario, National Grid also forecast the growing role of nuclear in the UK's energy mix from 2030, when most of the UK's existing AGRs start to be replaced by new plants, with nuclear capacity peaking at 16 GW by 2050, 7 GW of which is expected to come from SMRs alone.
There have been two significant recent announcements from BEIS in this area: the first related to getting SMR funding off the ground; the second to a consultation on the applicability of the Regulated Asset Base (RAB) model in funding nuclear new builds.
Below, we consider the implications of these announcements.
SMRs back on track?
While it had seemed the nascent SMR programme had ground to a halt a couple of years ago, it now appears to have been revived by BEIS' proposal, announced on 23 July, to invest up to £18 million of government money in new mini nuclear power stations.
It has indicated this cash will support a Rolls-Royce-led consortium (including Assystem, SNC Lavalin/Atkins, Wood, Arup, Laing O’Rourke, BAM Nuttall, Siemens, National Nuclear Laboratory and Nuclear AMRC), which is proposing a joint investment of more than £500 million in designing a first-of-a-kind SMR.
The rationale for SMRs is that they are smaller and less expensive to construct than traditional nuclear units, which should in principle allow large-scale and reasonably standardised deployment (allowing for local siting considerations).
BEIS and the consortium anticipate that a demonstration model will be operating in the early 2030s.
The number of "homes powered" (the government's preferred metric for expressing energy capacity) is 750,000 homes per SMR unit.
BEIS is also intending to make four grants of up to £10 million each under the Advanced Modular Reactor (AMR) programme, for which it is currently considering project bids.
AMRs intend to develop and deploy new cooling systems, or use new fuel types, rather than being scaled down evolutions of existing reactor types, like SMRs.
BEIS has made an additional £5 million available to the UK's nuclear safety regulator, the Office for Nuclear Regulation (ONR), and the Environment Agency (EA) to allow them to prepare for the arrival and licensing of the new SMRs and AMRs.
The Regulated Asset Base model
After enduring a fair amount of public criticism for the price and tenor of the CfD strike price for the Hinkley Point C (HPC) nuclear project in Somerset, and after having tried everything short of a 100% state-backed guarantee for the Horizon project, BEIS is hoping for better luck with the RAB funding model.
BEIS hopes that RAB can provide the solution to problems of financing Horizon and with the National Audit Office's somewhat negative analysis of the HPC financing.
The goal is to bring forward private sector capital (particularly pension and insurance funds) at a cheaper cost.
BEIS specifically notes the need to create "a more typical infrastructure investment profile where investor exposure to risks and their returns are bounded".
Specifically, the model needs to suit complex development projects with high front-end capital requirements, long construction periods and long operating lives.
The new RAB consultation boldly declares that:
"[The] RAB approach could present a sustainable and value for money model for funding new nuclear projects. It has the potential to attract significant investment for new nuclear projects at a lower cost to consumers, enabling low carbon power to be delivered at scale."
This confidence is somewhat undermined, however, by the tentativeness of the first consultation question, which reads:
"Have we identified a model which could raise capital to build a new nuclear power station and deliver value for money for consumers and taxpayers?"
The RAB approach
The RAB model is not widely known, as its use has been limited to monopoly infrastructure assets (power networks, water and gas infrastructure etc.).
Hitherto, the £4.2 billion Thames Tideway sewer project, which is under construction in London, has been the flag-bearing project for RAB.
In its most basic form, a RAB model requires an economic regulator (Regulator) who licences a developer (Project Co) to operate a regulated project in exchange for a payment from users.
The Regulator administers a specific regulatory regime (Economic Regulatory Regime or ERR), under which costs and risks for the project are apportioned between consumers, Project Co and investors.
Electricity suppliers are required to raise a levy from consumers (as with existing low carbon subsidy regimes) which is released in stages, on a variable rather than fixed basis, by the Regulator to Project Co (Allowed Revenue).
Allowed Revenue would extend to all incurred and approved capital expenditure on the project (including any mandatory costs, such as the funded decommissioning programme), and would be paid over both the construction phase and the operational phase, together with an agreed return on capital (Weighted Average Cost of Capital, or WACC).
Cost approval could be carried out through a periodic review of incurred costs (i.e. on an ex-post basis), or through employing a target cost mechanism with pre-agreed categories of approved costs (i.e. an ex-ante basis).
BEIS prefers the latter for the greater certainty it would give investors, and for the traditional incentivisation reasons (in theory at least, a target cost incentivises the developer to come in under budget so it shares some of the saving and, conversely, is not exposed to a share of any overspend).
Why would RAB be cheaper than a CfD?
The ERR is complemented by an agreed government protection regime against identified "low probability but high impact risk events" (Government Support Package or GSP).
RAB models differ from the CfD approach most significantly in relation to the timing of payments to the developer.
CfD-supported projects will only receive revenue payments on successful commissioning. This means the up-front development costs (which run into the billions for nuclear projects) and construction costs have to be funded by the developer and its investors.
A RAB-funded model is thought to be cheaper, largely because it enables earlier payments to Project Co – generally in line with actual construction of the project.
This significantly decreases the cost of capital for the project (because more and cheaper debt should be available), and the revenue also allows the earlier repayment of debt (including during the construction phase), limiting the cost of compound interest and delays to equity returns.
The GSP, in identifying and allocating certain of the key project risks to government (e.g. construction cost overrun above a threshold, regulatory and political risk, uninsurable risks and disruption to the debt markets) should also encourage other sources of funding to come forward on a more de-risked basis.
BEIS' consultation outlines a credible RAB proposal, but it acknowledges that it has postponed much of the important detail (particularly around risk apportionment, including construction cost overrun, approvals and payment sequencing) to the detailed design stages, which will entail further consultations, presumably next year.
That, together with the brevity of the consultation (which is around half the length of the CCS consultation announced on the same day), creates a sense that progress is a little too slow for developers.
It also belies the significant amount of work going on in the background to finance the next round of nuclear projects.
It remains to be seen whether National Grid are being too optimistic in even their scaled down expectations of the next stage of nuclear deployment.
Nonetheless, BEIS recognises that the key challenges to financing nuclear new build do not go away with the RAB model – and acknowledge both the scale of capital required and the need to find an investable approach to risk-sharing (at an efficient cost) without burdening consumers with risks that should properly sit at development level.
That pragmatic approach bodes well for what comes next.
This article was written by Hugo Lidbetter, partner and energy and infrastructure specialist at Fieldfisher. For more information on our sector-leading energy expertise, please visit the relevant pages of the Fieldfisher website.
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